Category 7

With all of the stock market volatility at the moment, should I keep all of my money in cash?

As I type this it has been another bad day for equity investors. The FTSE 100 index plunged over 250 points to finish the day at 5,858.9 – around a 4% drop in a single day. It has fallen by 12.77% since the high of 6,716.7 in mid-July. Of course this is only one measure of the UK stock markets but these price drops are similar on a global scale.

The reason for this recent volatility appears to be largely the result of sub-prime lending in the US. Where US banks were lending to people with poor credit history they have become very exposed to debt that could not always been repaid. To make things worse they were repackaging this debt and selling it on to other companies as an investment. This has caused the problems to spread.

Nobody can say with any certainty what the stock market is going to do over the short term. We do know that over the longer term stock market investments tend to grow at a rate faster than price inflation. This leads to what we call a ‘real return’ for your money.

Cash is the most cautious asset class. If you want certainty over the value of your capital then cash is the place to be. You can be sure that the value of your capital will be the same when you take the money back out as it was when you put it into cash savings. The rate of return you get on your cash will vary in line with interest rates, although it is possible to fix the return for a specified period of time.

Keeping your money in cash is not completely without risk. As well as the risk that interest rates will fall, there are two other types of risk that you should be aware of. Firstly, the long term return you get from cash is not likely to keep pace with price inflation. This effectively erodes the value of your capital over time if you keep it all in cash. Secondly, there is always the small risk that the institution you keep your cash with (the bank or building society) will go bust. If this were to happen you would get limited protection from the Financial Services Compensation Scheme. It can make sense to keep your cash savings in more than one place to minimise this particular risk.

I’ve heard a lot about the opportunities available from investing in India. What do you think?

With the 60th anniversary of India’s independence this year and a booming economy, India has become a big investment story. The growth of the Indian economy is currently around 9% a year which is attracting investors who expect to see high levels of growth from their investments in Indian companies. However, investing in India does represent a high risk. Investors with an appetite for risk might consider investing in this region but should not expose more than 5-10% of their total portfolio.

Our main concern about this region is that they have not been spending a high enough level of money on infrastructure development. This means that the current high levels of economic growth may not be sustainable over the longer term. China, for example, appears to be spending much more money on infrastructure development in order to be able to sustain their economic growth.

There are a limited number of investment funds available that only invest in Indian companies. An alternative to consider is a ‘BRIC’ fund. These funds invest in the emerging markets of Brazil, Russia, Indian and China; hence the name ‘BRIC’. These countries are considered to be the four leading emerging markets in the world with the best potential for long term growth. These funds are also high risk but with a BRIC fund your investment is at least spread between four emerging markets rather than a single economy. You still get some exposure to India but with some additional diversification.

Martin Bamford is Joint Managing Director of award-winning Independent Financial Adviser (IFA) firm Informed Choice Ltd (www.informedchoice.ltd.uk).

He is also author of best selling personal finance guide, The Money Tree (£9.99, Prentice Hall Business). His second book, Brilliant Investing, will be published in November 2007 (£12.99, Prentice Hall). This article is provided for general consideration only and the information contained herein is not to be acted upon without professional independent financial advice.